Category: Finance

The Economy is “booming” and Trump is busy tweeting victory laps but watch out the stock market is noticeably over valued. This is simple math. Price to Earnings ratios are “out the roof”. The current P/E ratios for the major indexes are available from the Wall Street Journal. The SP500 P/E is currently 24.40. Historic data is available from many sources, I used Multpl.com. The median SP500 P/E is 14.73 over the last 100+ years.

P = Price per share, E = Earnings per Share and P/E is the ratio of Price over Earnings.

Using x for the P/E ratio we get : x = P/E. Assuming an arbitrary and hypothetical stock price of $100.00 per share and a P/E of 24.40 would result in an earnings per share of :

x = P/E so E = P/x so plugging in figures E = 100 / 24.40 = 4.10 = E

So our hypothetical stock priced at $100 per share has an earnings per share of $4.10. Now what happens if we keep Earnings Per Share constant and adjust market to historical market expectations of a P/E of 14.73 ?

So if the market expectations correct to normal P/E values this hypothetical stock ( and the stock market ) will drop by 39.61%. That is a price drop from 100 to 60.39 is a 39.61% drop.

We have had several drops of this magnitude, and two greater, in the history of the markets. The corrections of ’61, ’68, ’80, and ’87 were comparable. The corrections of ’29 and ’07 were substantial more severe.

Does the above mean the market will crash ? Not necessarily. There are three basic ways out of this, over time. First as illustrated above expectations return to normal and the price adjusts accordingly. Second earnings increase over time and expectations normalize over time making for far less drastic impacts over a longer period. Third inflation returns with a vengeance and the stock price never goes down in absolute dollars, earnings appear to climb due to inflation and price appears to climb as well but in current dollars a stealth correction happens. Likely a combination of all three of these will happen.

A question one undoubtedly will ponder about Special Needs Trusts ( alternately Supplemental Needs Trust ) is about the morality of the instrument. This may not be pondered until the trust is actually funded. It may be pondered by the trustee, by the beneficiary, by anyone who has knowledge of the trust.

The question naturally arises because the Special Needs Trust allows a person to have a very large amount of assets available for their benefit and still qualify for means tested government benefits. It can look like a loophole, or gaming or exploitin g the system.

This thought arises due to the juxtaposition of two competing ideas. The first being “welfare is for the poor” and the second being “disabled need care”.

The key distinction is to realize that a Special Needs Trust doesn’t exist because clever lawyers found a way to exploit a miswording or nuance of the law. The Special Needs Trust exists because Congress decided to create it in statute. It was created because the disabled require more care than the non disabled. They will have spending needs that are higher than those of the non disabled. They should not be placed at a disadvantage because of that. Further those little extras that someone can provide to a disabled person while they are alive that will help offset the difficulties of a disability should be able to persist even after the benefactor ( usually a parent or grandparent ) passes away. The mechanism for that higher level of care is through the private funding of individuals on behalf of the disabled person while still letting the disabled person maintain means tested benefits. Further Congress has in the last few years expanded the idea by the creation of 529 Able accounts, which in many ways function like a prepackaged Special Needs Trust.

The creation and utilization of a Special Needs Trust is following the intent of the congress, and the president who drafted and signed the laws into existence. Its done for the benefit of those with disability to allow them to benefit from our societal belief that the disabled need care, even state care, and yet at the same time allow them to have a life style above that of mere subsistence.

One of the things not highlighted during the last campaign season is that real estate prices have generally recovered. The fiscal crisis was not the making of President Obama. It was the inheritance of a disaster that came to fruition in the tale end of President George W. Bush.

On December 13, 2016 President Obama signed the “Special Needs Trust Fairness Act” into law. This law makes a simple amendment to 42 U.S.C. 1396p(d)(4)(A)adding the phrase “the individual” so that it now reads.

(A) A trust containing the assets of an individual under age 65 who is disabled (as defined in section 1382c(a)(3) of this title) and which is established for the benefit of such individual by the individual, a parent, grandparent, legal guardian of the individual, or a court if the State will receive all amounts remaining in the trust upon the death of such individual up to an amount equal to the total medical assistance paid on behalf of the individual under a State plan under this subchapter.

This simple change now allows physically disabled but mentally competent people to establish their own Special Needs Trusts. Previously this could only be done if their parent or grandparent did it, or if they were incompetent their guardian could, or perhaps via a court order.

The net is that more disabled people can benefit from the Special Needs Trust’s ability to shelter assets from the draconian limits imposed by SSI and Medicaid. With the usual caveat that upon their death all assets in the Special Needs Trust revert to Medicaid, or at least enough to repay Medicaid for all of its expenditures for the beneficiary over the lifetime of the beneficiary.

One of the most exciting things the Obama administration has accomplished with respect to caring for those with disabilities has been the creation of ABLE 529 accounts. At first glance these accounts appear very much like a 3rd Party Supplemental Needs Trust.

The advantage to a ABLE 529 over a 3rd Party Supplemental Needs Trust are cost, confidence, and ease of administration. Setting up a 3rd Party Supplemental Needs Trust usually requires attorney time for drafting of the trust. Then you have the open question of “will this trust be approved” when it is submitted for SSI and Medicaid etc., often there is a back and forth period between the attorney and the government, sometimes with the need to revise the trust etc. Finally you need a trustee, corporate trustees are expensive, private family may lack the investing acumen and also fail to keep proper records etc. and jeopardize the trust by causing it to be declared a countable resource. The ABLE 529 at first glance is a Supplemental Needs Trust in a can. Fill out a few forms, submit some proof of disability etc. and voila you have a Supplemental Needs Trust with no need to have it drafted and absolute certainty it will be approved.

The single biggest difference with a 3rd Party Supplemental Needs Trust and ABLE 529 is that with the ABLE 529 the money is owned by the beneficiary, it is available to the beneficiary ( while not being a countable resource for benefits). The beneficiary has the ability to withdraw the funds as they see fit, spend it as they see fit, and presumably keep the necessary records to document that their expenditures were appropriate. On the one hand this gives the beneficiary a level of autonomy that in fact may be the goal in planning for a disabled person in the hope of their having a life that is as normal as possible. On the other hand, depending on the nature of the disability, the nature of the person in general, etc. this may not be desirable. A Trustee managing the trust may be better suited to ensuring the funds are not spent to soon and depleted before the life span of the beneficiary was completed. The Trustee may be better at keeping the paperwork up to date to ensure that all expenditures meet the requirements of the various government agencies. This can be particularly important for those with mental or behavioral disabilities, but can also be important for many people with only physical disability who, like many non disabled, simply cannot manage money for the long term and instead have spendthrift tendencies.

There are many people who are not under a guardianship but who need a gatekeeper to manage their money. For example Social Security “Representative Payee” to manage their benefits. The Supplemental Needs Trust manages this indirectly because of the requirement they never giving the beneficiary money directly. The combination of Representative Payee and Supplemental Needs trust works in cases of fiscal irresponsibility mainly because the beneficiary never gets their hands on the money. It is unclear how this would be achievable with a ABLE 529 at this time. Its a question I’d like to see clarified.

A huge open question with ABLE 529s regards housing and how they will interact with HUD Section 8 subsidies. Special Needs Trusts are having serious challenges threading the needle between the differing program requirement of HUD and SSI/Medicaid. Of note ABLE 529 expenditures for housing will not reduce SSI/Medicaid, at least the way I read it but this should be verified. SNT expenditures would reduce SSI under the In Kind Support and Maintenance ( ISM ) rules. It may be that HUD will treat ABLE more favorably because it is a government program, but that remains to be seen. Currently for non HUD Section 8 recipients I think housing money should be routed into the ABLE account and then back out to pay for rent without reducing SSI.

The other issue that limits the ABLE account is the $14,000 annual contribution limit, and to a lesser extent the limit on total assets in the account. A beneficiary who will be left a significant amount of money will require a means to manage periodic distributions into the ABLE account. The natural mechanism for that is a separate trust that exists along with the ABLE account. Thus the ABLE account will not replace a 3rd Party Supplemental Needs Trust in the near term but instead will be a valuable tool complementing a Supplemental Needs Trust. The able account can help to provide a channel for routing funds to work around ISM issues. And issues around finding a competent trustee and reducing costs of establishing a 3rd Party Supplemental Needs Trust may be handled by using a competent Pooled Trust solution.

The surprise election of Donald Trump to the White House has produced another surprise. Sharply rising interest rates. What was for 10 year treasuries an interest rate of 1.783 on Monday is on Friday 2.113 % as I type this article.

The FED has made no announcements, this interest rate swing is purely based on the speculative anticipation of a Trump presidency and the policies he will introduce. This is significant as for the last several years the specter has existed that the FED primarily controlled the economy and did so purely with the interest rate lever and the QE purchase lever.

Whether Trumps policies will be good for the nation or not clearly remains to be seen. Rising interest rates bode well for those looking to get income out of a portfolio, assuming its not purely rising rates from rising inflation. Borrowers clearly will have a harder time of it. All in though we need to get rates up off the floor, and in many cases up from under the floor, and back to a normal range.

According to financial news today the Bank of Japan has announced a couple key things. First it wants to set a 10 yr bond target of zero percent. Second it wants to hit its inflation target of 2% or perhaps slightly higher. This is surrealism brought to finance. Its not limited to Japan.

The ten year bond return of 0% would still be higher than the current bond yield in Japan which is slightly less than zero. So zero is in fact an improvement. Setting a 10 year bond target and controlling it is a stunning objective in and of itself. The Bank of Japan, along with a lot of other central banks, have failed to achieve other targets. All would prefer a return to normal economic growth and yields. In the absence of the ability to control that they are now setting insanely absurd targets as a goal, like zero percent on a ten year bond.

Meanwhile markets have reacted to this news with gains for the day. When the markets view this news as positive it gives us some sense of just how distorted things have become.

The thing to consider is why. Stimulating growth is the goal of virtually all industrialized nations central banks. The operating premise is to much cash is on hand, negative rates might force the cash to be invested. Investing is how you produce growth because companies produce growth. But its whistling past the graveyard. The problem is not a lack of money to be invested, nor a lack of desire to invest it. The problem is a lack of reasons to invest. For growth to happen their must be an increase in demand on the part of the consumers. This has not happened. Japan is leading the way in that. The reason is there are fewer and fewer consumers. The way to increase demand is to increase the number of consumers. Negative interest rates do not increase the number of consumers.

Managing retirement funds for yourself or for another is a challenge. Part of challenge of answering “do I have enough money” or “how much money can I withdrawal each year” lies in knowing how long the person will live. Its a very impolite and seemingly immoral question to ponder “When are you ( or I ) going to die ?” In truth no one could answer it anyway. But it lies at the very heart of planning.

One approach is to simply look at the average life expectancy by birth year and gender. This information is available via the Social Security Administration, CDC and various online sources. The IRS relies on expected life expectancy to calculate your required minimum distributions. These of course are just averages. People live longer, lots longer. I believe the current average age at death is 83 years presently. I know, and have known, several to live into their 90s. I’ve known some to die much earlier.

The moral questions for funds you may manage for another center on, “Have I maximized the amount of money available to them during their life ?”. If a longer than actual life expectancy is chosen as a budget basis the result will be excess money left over unused. If a shorter than actual life expectancy is chosen the result will be running out of money in retirement and the pain of a drastic life style adjustment that goes with that.

Generally I believe that estimating high on life expectancy is the right path. Its what I plan for myself and it is what I would suggest anyone plan on. It also is the more palatable option than saying “Ya I think you ( or I ) are going to die much younger than we hope.”

As negative interest rates spread, Germany is also now offering negative bonds, an opportunity is created. The longer rates stay near, at or below, zero the more a sovereign nation can finance its debt at zero interest. Unlike consumers the sovereigns can than, to the extent debt is financed in their own currency, kick the inflation option full speed ahead after they get enough debt at 0% and make a lot of their current debt vanish through inflation. To the extent doing that is in the interest of more than one nation, and it would be, that suggest a real possibility of a soon and sudden pivot back to inflation.

There is a certain myth that if we valued our money in gold instead of fiat it would have a stable value. The history of coinage and minting shows that this is not true. Consider this short summary of coinage history from Adam Smith in the 1700s.

The denominations of those coins seem originally to have expressed the weight or quantity of metal contained in them. In the time of Servius Tullius, who first coined money at Rome, the Roman as or pondo contained a Roman pound of good copper. It was divided, in the same manner as our Troyes pound, into twelve ounces, each of which contained a real ounce of good copper. The English pound sterling, in the time of Edward I. contained a pound, Tower weight, of silver of a known fineness. The Tower pound seems to have been something more than the Roman pound, and something less than the Troyes pound. This last was not introduced into the mint of England till the 18th of Henry the VIII. The French livre contained, in the time of Charlemagne, a pound, Troyes weight, of silver of a known fineness. The fair of Troyes in Champaign was at that time frequented by all the nations of Europe, and the weights and measures of so famous a market were generally known and esteemed. The Scots money pound contained, from the time of Alexander the First to that of Robert Bruce, a pound of silver of the same weight and fineness with the English pound sterling. English, French, and Scots pennies, too, contained all of them originally a real penny-weight of silver, the twentieth part of an ounce, and the two hundred-and-fortieth part of a pound. The shilling, too, seems originally to have been the denomination of a weight. “When wheat is at twelve shillings the quarter,” says an ancient statute of Henry III. “then wastel bread of a farthing shall weigh eleven shillings and fourpence”. The proportion, however, between the shilling, and either the penny on the one hand, or the pound on the other, seems not to have been so constant and uniform as that between the penny and the pound. During the first race of the kings of France, the French sou or shilling appears upon different occasions to have contained five, twelve, twenty, and forty pennies. Among the ancient Saxons, a shilling appears at one time to have contained only five pennies, and it is not improbable that it may have been as variable among them as among their neighbours, the ancient Franks. From the time of Charlemagne among the French, and from that of William the Conqueror among the English, the proportion between the pound, the shilling, and the penny, seems to have been uniformly the same as at present, though the value of each has been very different; for in every country of the world, I believe, the avarice and injustice of princes and sovereign states, abusing the confidence of their subjects, have by degrees diminished the real quantity of metal, which had been originally contained in their coins. The Roman as, in the latter ages of the republic, was reduced to the twenty-fourth part of its original value, and, instead of weighing a pound, came to weigh only half an ounce. The English pound and penny contain at present about a third only; the Scots pound and penny about a thirty-sixth; and the French pound and penny about a sixty-sixth part of their original value. By means of those operations, the princes and sovereign states which performed them were enabled, in appearance, to pay their debts and fulfil their engagements with a smaller quantity of silver than would otherwise have been requisite. It was indeed in appearance only; for their creditors were really defrauded of a part of what was due to them. All other debtors in the state were allowed the same privilege, and might pay with the same nominal sum of the new and debased coin whatever they had borrowed in the old. Such operations, therefore, have always proved favourable to the debtor, and ruinous to the creditor, and have sometimes produced a greater and more universal revolution in the fortunes of private persons, than could have been occasioned by a very great public calamity. — Adam Smith, Wealth of Nations, Book I Chapter IV The Origin and Use of Money

Apparently when official stamping of coins began it was taken solely as evidence of the quality of the metal contained, the purity, but the coins were still weighed. Once the move to counting the tally of the coin only it became possible for kingdoms to intentionally erode the value of their currency, and they did.

Everything old is new again. There is nothing new under the sun.

The thing to really ponder in the above is the line “Such operations, therefore, have always proved favourable to the debtor, and ruinous to the creditor…”. Leverage is powerful but it is dangerous in a retraction. Kings have always borrowed money. Banking though, fractional banking, is both borrowing and lending. Taking deposits, which are essentially loans to the bank from the depositor, and lending that back out to others, the banker making their money on the spreads. No conclusion is reached here but it certainly is something to ponder if you have nothing else to do on a rainy day.